Decision makers and analysts look deeply into profitability ratios to identify t

Question

Decision makers and analysts look deeply into profitability ratios to identify trends in a company’s profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply.

a) A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both.

b) If a company’s operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.

c) An increase in a company’s earnings means that the profit margin is increasing.

d) If a company issues new common shares but its net income does not increase, return on common equity will increase.

Explanation / Answer

Below 2 statements (a & b) are true a) A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both. b) If a company’s operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. FALSE c) An increase in a company’s earnings means that the profit margin is increasing. Since company earnings can also increase when there are more sales even though profit marginmay be less.Thus an increase in company earning does not always mean that profit margin is increasing d) d) If a company issues new common shares but its net income does not increase, return on common equity will increase. Since Return on Equity will decrease to to increase in equity and no change in income

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